House Rugged

Moontower Munchies #11

Friends,

Here’s a 6-minute read for your pleasure:

“Incentives to produce” are incentives to rig the game by Interfluidity

This essay contends that the cost of mitigating inequality is likely small compared to its benefit. Rent-seeking behavior is inevitable but the incentive to capture rents or grift is stronger if the potential prize is bigger.

1) It starts with a reference to the ever-present efficiency vs equity tradeoff:

Reducing rewards to those at the top of the wealth/income distribution might blunt their incentives to produce. But the cost of that might be offset by utilitarian benefits of transfers to the less well off...But at current margins, I suspect there is no tradeoff. There might be a tradeoff in measured GDP, but GDP happily tallies economic coercion and rent-capture along with genuinely productive activity...Causing a disease and then expensively treating it does not in fact make the world richer. But it may well inspire economic activity — the mass production of a new drug, visits to doctors, extra hours people choose to work in order to afford the treatment, etc. In aggregate, we work harder just to stay in place. But the distributional effects of the operation are very real.

A personal favorite example of economic policy trade-off thinking is adjacent —it pits price discovery vs distributional effects. Here’s Byrne Hobart:

The defense of 1031 exchanges is that they encourage growth because they keep people spending money on new property developments instead of cashing out and enjoying their gains. Which embeds two assumptions:

1. It’s generally better to tax consumption than investment, and

2. Real estate investment is a particularly worthy kind of investment to avoid taxing.

Assumption #1 sounds true, but is circumstantial. Assumption #2, though, is hard to defend. Real estate speculation does produce jobs, but it also produces macroeconomic volatility and sometimes threatens the financial system. From a macroprudential perspective, where the goal is to reduce the odds of financial crises, it might make more sense to have 1031 exchanges for everything but real estate: sell your company, and you can roll the money into starting a new one; sell a mall or skyscraper, and you get taxed. But it’s always fiendishly hard to predict the long-term incentives created by a change in the tax code. Any tax on realizing gains, for example, is implicitly a subsidy on borrowing against appreciated assets instead of realizing those gains. If that’s true, the net effect of eliminating 1031 exchanges would be that real estate portfolios would turn over less often. If we assume that people vary in their ability to make good real estate investments, this would mean that the best such investors wouldn’t make as many discrete investing decisions, which would make prices a bit less efficient. This might be a reasonable tradeoff: making real estate investing a less tax-optimal choice could be a fair trade in exchange for making real estate prices less reflective of their value. But it’s still a tradeoff, not a straightforward benefit. Quirks in the tax code become load-bearing over time; even if they didn’t make economic sense when they were made, the structure of the economy only makes sense in light of the tax incentives that economic actors have already responded to. If you assume that people are reasonably good at reacting to incentives—or, more plausibly, that over time the people who are good at doing this end up controlling more assets—then any change in those incentives has complicated and unpredictable results.

2) It continues by explaining rent capture increases are a natural defense to technology’s unseating effects:

We should expect the prevalence of rent capture (or worse) as a source of economic profit to increase with technological progress. Why? Because, absent chicanery, technology increases the ease of production and the efficiency of distribution. As Schumpeter pointed out, the source of profit in real-life capitalism is the fact that monopoly power is ubiquitous because of natural barriers to competition...Technological progress renders moats that derive from nature harder to come by. Instead, successful businesses — and successful people (since under capitalism, a human is just a small business) — must rely increasingly on moats that result from social and political arrangements....The distribution of profits is determined by social choices rather than by natural scarcities.

3) This is not necessarily wrong but if you care about social cohesion it's problematic because it creates incentives to side with the winners:

But the distribution of affluence is less and less a matter of direct attachment to production, and more and more a function of winning social games and political contests that determine to whom the fruits of production will be allocated. There’s no conspiracy in that. Nor is it an answer to say “capital” now determines who enjoys wealth. As technology improves, capital goods become mere commodities like everything else. Financial capital, whatever it is, is not an input into any material production process. It is a construct and artifact of a huge and ever-changing array of social and legal institutions. “Human capital”, “social capital”, and “organizational capital” are things we impute ex-post to winners of distributional contests as explanations of observed returns. They do not straightforwardly exist in the world...high dispersion of outcome creates a strong incentives to be on the side of winners.

4)As this incentive crosses over into the perverse, it not only creates inequality but also inefficiency. I see it as a socially divergent process once it tips too far:

a well-ordered society depends upon people sometimes making choices opposed to their material interests on ethical or other grounds. Then it is obvious how inequality might be costly. Instead of talking about “incentives to” (produce, extract rents, whatever), we might describe outcome dispersion as a tax on refraining from mercenary behavior. If the difference between economic winners and losers is modest, people of ordinary virtue might refrain from participating in activities they consider corrupt, might even be willing to “blow the whistle”, because the cost of doing so is outweighed by their preference for behaving well. But as outcome dispersion grows, absenting oneself from or even opposing activities that would be personally remunerative but socially undesirable becomes too costly.

5) I hate to do it, but I gotta invoke Moloch:

Wouldn’t it be odd to live in a country where, say, bankers individually acknowledge that their industry often behaves destructively, where insiders perceptively describe the conditions that create incentives for people to take bad risks or fleece “muppets“, but continue to work in those places and do nothing about it? Wouldn’t it be odd to live in a country where doctors privately apologize for the way their services are “priced“, but nevertheless take home their paychecks and pay AMA dues? Or in a country where economics instructors teach agency costs using textbook pricing as a case study, during a course for which students are required to purchase a $180 textbook?... In all of these cases, there really isn’t anything any one individual can do to remedy the bad practices. Making a big issue of them would lead to useless excommunication. Instead we shrug ironically. In our society, an ironic attitude is a token of sophistication (a telling word, that once meant corruption but now implies competence). An ironic attitude towards collective ethics is adaptive. It helps basically decent individuals participate in coalitions that ruthlessly contend for rents. But perhaps we’d have a better society if, rather than turning our ethical discomfort into an object of aesthetic consideration, lots of us worked straightforwardly to remedy it. And perhaps more of us would do so if the risk of losing our place were not so terrible. Ethical behavior is endogenous. “Inequality” renders it costly.

I will leave the reader to let this marinate in the context of Carse’s idea of finite vs infinite games. (The goal of a finite game is to win; the goal of an infinite game is to keep playing.)

Finally, as housing affordability continues to be the mother of societal short-squeezes, this post gives a high-level description of the NIMBY/YIMBY divide - a conflict that underpins the American pillar of home ownership.

• House Hoarders by Maia Mindel (8 min read)
  
  I will point you to one bit I hadn’t heard before. It’s not a central point in this piece but food-for-thought:
  

  The importance of location is also influenced by social networks: more inter-class friendships are strongly associated with higher economic mobility. This might explain one of the more baffling facts about economic mobility: the only group to consistently have it, in the United States, are the children of immigrants— and it’s not attributable to education. Given that it’s true for immigrants all over the world, and varies within regions, it can’t really be “culture” either. An option, thus, is that immigrants tend to cluster in certain industries and in certain locations — meaning they do have the kind of “interclass networks” everyone else lacks.

  
  The keyword here is “interclass”. If we measured social mobility conditional on interclass interaction we might find that mobility is highly skewed towards immigrants and overstated as a general property of the US. If you feel like the ladder has been kicked in this country relative to the past, a large muscle movement in restoring mobility would be to think about how to encourage such inter-class cooperation along a broader axis than ethnicity.
  
  [I think college provides such a mechanism speaking from my own, my wife, and many of our friends’ experience but this is a generation ago and I’m not informed enough to generalize this on its face or with respect to how expensive it’s become.]

Stay groovy

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